Canada - The Land of SaaS?

When Bessemer Venture Partners recently published their map of major cloud players, I was surprised to see so many Canadian companies on there.

Shopify, TribeHR, Unbounce, Clio, Hootsuite, Radian6 and Freshbooks made the list and a few others (like Wave Accounting) probably should have been on there as well.

So why are Canadian companies so much better represented in SaaS than in consumer internet?

I see two main reasons:

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ALL IN is not a wise strategy

I have seen my fair share of entrepreneurs that were “all in” – mortgaged their house to the max to get their start-up going, using their credit card limits to make the next payroll, close to personal bankruptcy at any moment.

There are probably tens of thousands of cases where this strategy was successful: the new funding came in just before the lights finally went out, the closing of a big sale brought in new revenues, a line of credit was extended. These are the stories we mostly hear about. But there are millions of situations where this “all in” strategy did not work out and the entrepreneur was left with nothing at all, having lost their company, their house and sometimes even their family (that didn’t want to share that type of life anymore).

Taking risks is the key to entrepreneurial success and I have an incredible respect for people that invest a large amount of their own money into their start-up. But in my opinion it is about taking measured risks and not going “all in”. If you are “all in”, you often take bad decisions as you are not able to cope with the pressure from your family or your company anymore. Or you take bad decisions because you run out of alternatives and time.

So take a measured approach and never invest all of your money in your start-up but keep enough dry powder in case things don’t turn out as planned. You will be a better entrepreneur and family man.

After Angelgate, a good moment to go back to the basics

By now, everybody should have heard about Angelgate, from Arrington’s initial walk into the secret meeting of Silicon Valley super-angels to Dave McClure’s blog post as a response to Ron Conway’s email distancing himself from whatever was going on.

A lot of drama during these past 3 days, too much drama in my opinion. And drama that had been building up over the past months with the ongoing discussion around super-angels versus VC’s. So after this crescendo, it might be a good time to take a step back and go back to the basics. And if you strip off all of the noise, a few simple truths emerge:

  • Entrepreneurs are king: they create the value, they are the customers of investors. And thanks to programs like YCombinator and generally lower capital requirements for start-ups, entrepreneurs are in a better position than ever before when it comes to negotiating deal terms.  No investor – if super-angel or VC – will be successful in the long run if they do not respect entrepreneurs and treat them fairly.
  • Investors want to make a buck: as much as I wished that investors would only be in this game to be part of shaping innovation and helping entrepreneurs (as Ron Conway seems to be), it must be clear that they need to create significant returns and therefore need to protect their interests as well. A large part of angel investing is driven by passion for entrepreneurs and start-ups and not primarily by the need for financial return but this is unfortunately not a scalable system to bring more money into the ecosystem. We need investors that are driven as much by passion for entrepreneurs as by making a buck.
  • Angels and VC need each other: they are part of the same ecosystem and provide money and mentorship at different stages of a company life cycle – sometimes they compete for deals, most often not. So the ongoing super-angels versus VC discussion seems artificial.
  • Investors need to add value: it does not matter if you are a super-angel, a micro-VC or VC – if you don’t add value on a daily basis, you will neither have many successful start-ups in your portfolio nor get great deal flow in the future.  So start collecting karma points!

The ecosystem is shifting – less capital is required, funds get smaller, new entrants have emerged, entrepreneurs have gotten more powerful – but these 4 truths were valid before this shift happened and are even more valid today. So let’s remember them, stop the drama and go back and build companies!

How to become a (successful) angel investor

Angel investors are crucial for every start-up ecosystem and Canada certainly needs more of them (especially of the super-angel kind!). But angel investing is not only good for the start-ups that benefit from early and risk-taking investors, it can also generate great returns for the investors.

At least if they follow a few key rules. Mark Suster from GRP Partners published an excellent series of posts on angel investing in the past couple of weeks and I could not agree more with the 5 skills successful angel investors need to have: deal flow, domain knowledge, relationships with VC’s, deep pockets and access to buyers. From my own personal experience there are a few additional points to consider before launching yourself into angel investing:

  • Budget for angel investments: Determine how much money you want to allocate to angel investments over what period of time. Often people start investing without looking at the big picture and then end up with only 3 large investments before running out of money. In order to have superior returns and spread risk across a portfolio, you should invest in at least 10 deals. So if you want to allocate $1 million to angel investments, don’t invest more than $100K per deal, preferably even less to leave room for follow-on investments.
  • Pace: Once you are in the market, you will most likely be flooded with investments opportunities and in the beginning an apparent abundance of opportunity will meet a lack of patience on the investor side: you want to build up a portfolio and get your feet wet and all those opportunities look great. But take it easy, especially in the beginning. You will quickly learn how to differentiate the good from the bad deals but it will take time to build up this experience by looking at a lot of deals. So my recommendation is to rather watch and see in the first couple of years instead of getting into the action too quickly – you will most likely burn quite some money with the latter strategy!
  • Entrepreneur vs investor view: A lot of entrepreneurs turned investors look at an investment opportunity with their entrepreneurial eyes and imagine what they could do with the business if they ran it. But this is unfortunately not the right way to think about this opportunity as it is  much more important to evaluate if the entrepreneur who is pitching the idea is able to execute against it or not. In the end, he is running the company (and not you) and in most cases it is not the idea that defines the success of a start-up but the execution.

So keep all of these points in mind when you start doing angel investments and I am sure you will not only enjoy helping start-ups but also enjoy some healthy returns.

What GROW means for the Vancouver tech community

For the next 3 days the Valley descends on Vancouver for the GROW conference and you can feel a real excitement in the local tech community about hosting entrepreneurs like Tony Hsieh (Zappos) or Andrew Mason (Groupon) as well as investors like Rob Hayes (First Round Capital), Dave McClure (500 Startups), Jeff Clavier (Softtech) or Chris Albinson (Panorama Capital) here in town.

Building a company outside of the hot spots of the Valley or NYC is sometimes a tough undertaking despite many success stories – entrepreneurs don’t have the same easy access to experienced talent, mentors or investors and have fewer opportunities to learn from peers. So having close to a hundred top notch tech entrepreneurs and investors coming into town gives the Vancouver tech community a real boost and will provide some fantastic learning and networking opportunities for entrepreneurs from here and the rest of Canada.

Big thanks to Debbie Landa from Dealmaker Media for organizing the event, really hope this will turn into an annual conference!

What kind of company can you build outside of the Valley?

I often get asked by investors and entrepreneurs alike how building a startup outside of Silicon Valley is possible and I always answer that it depends on what kind of company you are trying to build.

So if you are trying to create the next Facebook, Google, YouTube, Twitter, or Foursquare and your company requires a large amount of funding and needs to be close to where the buzz is (because dozens of other startups are competing with you with exactly the same idea and the winner will take it all), then a “secondary market” like Denver / Boulder, San Diego, Seattle, Boston, Montreal or Vancouver is not the best place to be.

But if you have carved out a niche for your company that is a bit off the beaten track, are comfortable to do more with less money, bootstrap longer and grow your company a bit more organically, then any of those secondary locations could be the perfect place to start and build your company. You might not have the same access to money and senior talent but you usually have much lower costs of operating your company, access to great engineering talent without competing with the Google’s and Facebook’s of the world (and the salaries that they are paying) and an environment that sometimes makes it easier to focus on the real value of a product for customers compared to chasing the latest hype.

Not sure if you can create big companies in places like Edmonton, Kelowna or Victoria? Yes, you can! Take Bioware, the Edmonton-based gaming company that the two founders Greg and Ray built over a decade in a city that did not have not a single gaming company before they started their company – sold to EA for close to a billion dollars. Or Kelowna’s Club Penguin, a company that was the first to create a virtual world for kids and sold to Disney for over $750 million. Or my own company AbeBooks that got built in Victoria, BC, over more than a decade before being sold to Amazon.

Great companies are being started in these markets every day – they will perhaps not be as glamorous as the Valley startups but will still create enormous value for customers and subsequently exit opportunities for entrepreneurs and investors alike.

Why Demand Media (and similar models) will succeed

With Demand Media filing for their long-expected IPO last week, the discussion around scalable content generation platforms (or “content farms” as critics of those models prefer to call them) is back in full swing.

As an investor in Suite101 (the third-largest platform behind Demand Media and Yahoo’s Associated Content), I have been watching the space evolve over time and getting to understand and appreciate the business model behind these platforms. Since the Wired article on Demand Media last year a lot of the discussion in blogs has however solely focused on the algorithms versus humans topic with some people even calling for the “death of hand-crafted content“. 

What was discussed much less is the fact that these new content generation models provide crucial solutions for media companies in an Internet age characterized by fragmentation of audiences, high demand for long-tail content and increased performance-based monetization.  There are 5 key differences that make platforms like Demand Media, Associated Content or Suite101 superior to traditional media platforms for generating high-quality content in a scalable way:

  • Distributed model: having access to thousands of contributors around the world (instead of dozens or hundreds in a traditional media model) increases the chances of having a true (and often very passionate) expert writing about the topic of choice
  • Aligned incentives between platform and content creators: most content creators are being paid on a revenue-share basis (Demand Media also pays a fixed amount per piece but increasingly moves to revenue-share arrangements like Suite101 and Associated Content) which perfectly aligns incentives across all participants – you only get paid if the content you create generates revenues
  • Demand-driven content creation: all platforms use content guidance systems that help contributors understand what readers actually want and take the guessing game out of deciding what content to publish
  • Scalable editorial models: editorial oversight is being implemented based on scalable models that try to maximize efficiencies while guaranteeing the highest level of quality possible
  • Performance-based monetization: a large percentage of the content is being monetized through performance advertising like Google AdSense

Content generation platforms are often seen as pure search engine plays. And while it is certainly true that they all get a significant share of their traffic from Google and Co., I would argue that the long-term vision of all those platforms is a much broader one: to build up the largest talent pool of passionate contributors that can create highly targeted, high quality media experiences in the most efficient and scalable way, delivering value for readers, advertisers and contributors alike.

I personally think that this is how media will be created in the Internet age.

The Challenge for Canadian VC’s

VC funds go through challenging times world-wide but the situation in Canada is probably worse than in many other places. Most VC’s in this country have been focused on the domestic market, both for raising funds as well as investing their money.

Turns out that this created returns that were about 10% below the returns of their US counterparts which is not surprising given the size of the country and the fact that no technology sector in Canada plays a worldwide leading role (which is very different to the world of mining where Canada has created some of the most successful investors and entrepreneurs worldwide).

Those sub-par returns have lead to a reduction of the already small number of Canadian LP’s that have the resources and the interest to put significant amount of money into venture capital funds. While raising money from outside the country has been relatively challenging because of Section 116 (which makes tax treatment for US investors a time-consuming and painful affair), we have seen at least the provinces step up in recent years creating pools of money to invest in venture funds (e.g. the BC Renaissance Capital Fund).

While this has helped stabilize the Canadian VC industry in the short-term, it might worsen the situation in the long-term as most of these government-sponsored funds require the VC’s to invest a significant amount of the commitment back into companies from that province. What hasn’t created superior returns for the whole country, will create even less returns when scaled back to the geography of a province.

So what needs to happen is a change in mindset for all players in this market: We are competing for capital and talent internationally, not on a regional level. We need to get rid of all administrative hurdles like Section 116 and give Canadian VC’s the opportunity to build world-class firms that raise money from around the world and and invest in opportunities around the world. History has shown that most VC’s still invest their money above-proportionally in their home region so the net effect of such a strategy should be positive for everybody involved, including the entrepreneurs at home.

Why these tough times are good for Canadian Start-ups

These are definitely tough times for start-ups and it is amazing to see how quickly the mood has changed, from continued optimism despite the looming sub prime market meltdown to sheer panic after the stock market sell-off. Since the now-already-famous Sequoia presentation, many start-ups have already reacted by significantly cutting their burn-rate and more cutting is most likely to come. I think however that these tough times might actually be good for Canadian Internet start-ups and we could be coming out stronger from the crisis than before - here are the 3 main reasons for my thinking:

  • Canadian Internet start-ups never had access to abundant venture capital and are therefore operating on a much more competitive cost basis that many Silicon Valley start-ups. Actually, 4 out of the top 5 companies on the Techvibes Canadian start-up index have never raised any venture capital at all and grew organically.
  • The sharp decline of the Canadian dollar (now down over 30% YoY) means an important revenue windfall for all start-ups that get a majority of their revenues in USD.
  • The partly drastic downsizing of Sillicon Valley start-ups means that more talent is available on the market - talent that now might want to look at the opportunity of a different life-work-balance by joining a Canadian Internet-start-ups that tries to build something more long-term and more organically.

It would be great if we could turn this crisis into a major opportunity for the Canadian Internet scene. Some of the stars are definitely aligned.